A history of economic whac-a-mole

BERKELEY  —  The big lesson of the past 60 years of US economic policy, according to former vice chair of the US Federal Reserve and current Princeton University economist Alan S. Blinder’s new book, A Monetary and Fiscal History of the United States, 1961-2021, is that there is no big lesson.

There has been neither linear development nor much “progress” in figuring out how to manage modern economies in the interest of macroeconomic stability. Instead, Blinder describes “wheels within wheels, spinning endlessly in time and space … [with] certain themes … waxing and waning … monetary versus fiscal … the intellectual realm … the world of practical policy making … the repeated ascendance and descendance of Keynesianism ….”

The underlying story is driven, ultimately, by historical contingency. Problems appear and are either solved or not solved. Either way, the response sets the stage for a new and different problem to emerge, because the actions taken in the recent past left the economy more vulnerable in some way. But by the end of the story, one gets the sense that some of the problems were quite similar to one another, and that economic policymakers have been playing a never-ending game of Whac-A-Mole.

Consider the question of whether inflation expectations are well anchored. Can inflation be expected to ebb, or does it tend to be highly persistent, with each shift in the rate becoming permanently embedded in the likely future? When Blinder “entered graduate school in the fall of 1967... empirical evidence virtually screamed out that [it could be expected to ebb]... Theory and empirics clashed sharply. As Groucho Marx memorably asked, ‘Who are ya gonna believe, me or your own eyes?’ The view at MIT, as I recall, was go with your own eyes.”

Going with your own eyes was indeed the right thing to do. As economist Thomas J. Sargent soon showed in a “beautiful five-page paper” that was “underappreciated at the time,” much of the theoretical debate “was beside the point”, Blinder writes.

Now, the same problem is back. Do inflation expectations remain well-anchored or not? Is the answer the same as it was in the 1970s? It might well be, or it might not be. This is one of those rare moments where I am extraordinarily glad not to be on the Federal Reserve Board. Not only has the burden of responsibility become overwhelming, but the degree of our ignorance is much greater than usual.

More broadly, Blinder has given us a very nice read. His book lets us ride shotgun along the extremely rocky road that US policymakers have traveled in their quest for price stability, full employment, financial resilience, and robust investment. Each episode produced by the Wheel of Fortuna is strikingly and, I believe, almost completely accurately described. Read and absorb Blinder’s account, and you will be qualified to present yourself as a respected elder statesman who has seen much macroeconomic policymaking up close and whose advice warrants attention.

But are there any overarching lessons beyond the role played by Fortuna? One that I would point to is that while history (correctly handled) can be very useful in helping us understand current situations, theory (at least currently fashionable theory) is not. Blinder reminds us that monetarism “rose to prominence on a combination of some hotly disputed scholarly work, Milton Friedman’s singular brilliance and skill in debate, and perhaps most important the rise of inflation.”

In the event, Keynesianism “was unjustly tagged as inherently ‘inflationary’, and monetarism stepped forward as the replacement”, exerting “substantial influence on policy formulation in the United States, the United Kingdom, Germany and elsewhere”. But make no mistake: monetarism’s influence on policy was malign. “The policy debate was not, as Friedman and others sometimes claimed, over whether monetary policy mattered,” Blinder writes. “It was about whether fiscal policy not accommodated by monetary policy mattered. As it turns out, it did.”

Blinder then revisits the moment of New Classical Economics, whose claims about “policy ineffectiveness” went on to conquer “vast swaths of academia in the 1970s and 1980s”. Fortunately, central bankers largely, and rightly, ignored this school of thought: After Paul Volcker’s time as Fed chair, who could deny that policy had an effect on the real economy?

Similarly, Blinder raises questions whether the current theoretical workhorse, so-called New Keynesian DSGE models, is useful in helping policymakers understand those aspects of the world that most concern them. Here, I think he is absolutely right to be sceptical.

Two other lessons are worth mentioning. First, monetary policymakers who make their decisions on political grounds should count on their reputations being permanently tarnished. Fed Chair Arthur Burns’s reputation did not survive his excessive concern for Richard Nixon’s re-election in 1972. Similarly, Blinder argues that Alan Greenspan “tarnished his gold-plated reputation by seeming to endorse the [George W.] Bush tax cuts”, thus pushing the policy across the line in Congress in 2001, much to the country’s detriment.

Finally, using fiscal policy properly to manage demand and support growth is incredibly complex. The appropriate rules of thumb shift from decade to decade, and in ways that are impossible for the political system to comprehend in real time. This is a huge problem. Back in 1936, John Maynard Keynes thought that macroeconomic stabilisation required both fiscal and monetary policy, that it was attainable by technocratic management, and that such management could solve the two big problems of unemployment and income distribution. But, as Blinder’s book relentlessly demonstrates, we are nowhere close to that policymaking Nirvana today.

J. Bradford DeLong, a former deputy assistant US Treasury secretary, is professor of Economics at the University of California, Berkeley, a research associate at the National Bureau of “Economic Research, and the author of Slouching Towards Utopia: An Economic History of the Twentieth Century” (Basic Books, 2022). Copyright: Project Syndicate, 2022. 

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